Chesapeake Energy CEO in hot water again

Aubrey McClendon borrowed a staggering $1.1 BILLION against assets co-owned by his company, recently released financial records show:

(Reuters) – Aubrey McClendon, the CEO of Chesapeake Energy Corp, has borrowed as much as $1.1 billion over the last three years against his stake in thousands of company wells – a move that analysts, academics and attorneys who reviewed loan documents say raises the potential for conflicts of interest.

The loans, which haven’t been previously detailed to shareholders, are used to fund McClendon’s operating costs for an unusual corporate perk that offers him a chance to invest in a 2.5 percent interest in every well the company drills. McClendon in turn is using the 2.5 percent stakes as collateral on those same loans, documents filed in five states show.

The size and nature of the loans raise questions about whether McClendon’s personal financial deals could compromise his fiduciary duty to Chesapeake investors, experts who reviewed the documents told Reuters.

Three years ago, McClendon was in the middle of another controversy, after records were released showing McClendon’s compensation package for 2008 – arguably the worst year in the company’s history – totaled $112 million, including a one-time bonus of $75 million.

As Chesapeake’s assets and market value were growing rapidly during the mid 2000’s, McClendon began purchasing large blocks of CHK stock on margin.  At its peak value of around $70 a share, McClendon owned around 5% of the company, a stake worth close to $2 billion.  But when energy prices and the stock market both collapsed during the summer of 2008, McClendon’s lenders began making margin calls on his stock purchases.  McClendon was forced to liquidate most of his shares in order to pay off his creditors.  After McClendon spooked investors by flooding the market with shares, and news about the heavy indebtedness of the company began to surface, CHK stock plunged to a devastating low of $11 per share, wiping out most of McClendon’s fortune.

At that time, many people speculated that the bonus was really more like a payday loan that provided McClendon with enough cash to cover his share of the operating costs tied to the 2.5% personal ownership stake that McClendon (as co-founder, CEO, and chairman) receives for every oil or gas well that Chesapeake drills.

Writing for, Christopher Helman has more to say:

Here is the core of what is wrong with McClendon’s massive borrowing: Chesapeake is severely capital constrained (a result of high debt loads, reckless spending on ever more shale gas acreage and rock bottom natural gas prices) to the point that the company is trying to sell billions of dollars in assets this year to make ends meet. At the same time this is going on, McClendon has been competing directly against his own company for access to the capital markets in order to shore up his own finances — without telling shareholders the extent of his financings.

Doesn’t he owe it to shareholders to put their capital needs ahead of his own? Shouldn’t shareholders know that the ceo of their company has found someone to lend him $1.1 billion against assets that they co-own with him? That’s an amount of money that is certainly material to a company with an equity market cap of $12 billion and debt load of $10 billion. This is an obvious conflict of interest, insufficiently disclosed, that should not be allowed to continue.

… And it’s not just this $1.1 billion in loans. I’ve also learned today that McClendon has entered into two private transactions called volumetric production payments, whereby he has collected more than $130 million upfront from banks and investors in return for delivering to them set amounts of gas from his wells for a certain period of time (in effect he’s sold them a temporary overriding interest). Though Chesapeake’s most recent proxy filing mentions that McClendon has done such VPPs, the deals were not announced at the time they were done, nor were the dollar values.

So how does this happen at all? McClendon has one of the best perks in the entire oil and gas industry. Every time Chesapeake drills a well across its millions of acres, McClendon gets a 2.5% stake in it. He has to pay a pro-rated share of the capital costs and expenses that go into those wells, but after that, 2.5% of the oil and gas coming out of that well, and 2.5% of the reserves down in the ground are his, free and clear.

Helman also points out another aspect of McClendon’s sweetheart deal.  Chesapeake has bought huge swaths of land as well as numerous mineral leases for land that it doesn’t own.  Not all of these assets will yield a profitable amount of production.  But McClendon’s deal means that his stake only includes profitable wells, while the company (and its shareholders) must absorb the losses for dry holes and acreage not used for production.

Not that it’s done him much good. Chesapeake’s most recent proxy filing sets out the financial performance underlying McClendon’s FWPP interests. In 2010 he received revenues from oil and gas sales of $127 million, but had to put up $268 million for his share of well costs and capital expenditures. That yielded a net capital loss of $142 million. This was worse than his $116 million loss in 2009 and his $63 million loss in 2008 (that was the year that he lost his fortune in Chesapeake shares after a margin call wiped him out). Gas prices have only been going down, so it’s likely that his last year’s FWPP losses were the worst ever. No wonder he needs a loan.

Now if McClendon’s prime slice of the Chesapeake pie is doing this poorly, it means the core oil and gas business underlying Chesapeake is just as bad, or worse. You can see it in their years of financial statements. The company doesn’t generate any free cash flow from operations; it’s only by playing the land game — acquiring acreage cheap and selling it at a premium to big, multinational companies like BHP Billiton, Cnooc or Total — that McClendon has kept the business going. That, plus taking on $10 billion in debt.

McClendon’s affability, generosity toward employees, vision, and guts have endeared him to many in the oil and gas industry.  He has built a billion-dollar company almost literally from scratch and in the process has created tens of thousands of jobs and billions of dollars in wealth.  His achievements have been noted by many and are rightfully applauded, particularly due to the fact that Chesapeake has received virtually nothing in the way of loans, grants, or subsidies from the Federal government.

But in his personal quest to become a billionaire, he has gone too far.  CHK closed today at $18 per share, down 44% from 8 months ago and down 73% from its peak value in June 2008.  It would be tragic if the Chesapeake board of directors allowed McClendon’s ego and desire to accumulate a huge personal fortune to sink the company.

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